The topic was a curious one. As Laurent and I discussed it over dinner last Wednesday, it became apparent that much of what we know refer to as internet business models are influenced by concepts previously applied in the strategy domain – network effects (see Eisenmann et al for strategies for two sided networks), lock-in, switching costs, long tail (power laws), cost leadership, differentiation (and by extension, the economics domain) etc. As we discussed various perspectives and articles, it became apparent the line between internet business models and strategy is increasingly blurry. Should we define internet business models in the context of how a business creates, captures and delivers value or how it generates profits (implying revenue generation and cost management)? The former would seem to bleed in to strategy – after all many companies have the same business model but achieve different levels of success. I left Laurent’s apartment, very late, with my mind in flux to what I should present.

Luckily, Paris is the ideal place for burning the midnight oil…literally. I reviewed some old presentations and articles and found that many of the articles Laurent and I had discussed, although recent in academic terms, were clearly out of date already – they did not foresee the rapid rise and adoption of social networking and the increasing ubiquity of computing, bandwidth and storage. It is easy to forget that Google and Facebook are still relatively recent phenomena. However, the business models hadn’t changed as fundamental in the last 2-3 years as I had first thought – it was more that the adoptions weightings had. The core Internet models are still – transaction, subscription and subsidy models and you can find them everywhere and in particular in the content sector e.g. videogames (gamestop, world of warcraft, farmville) and music (iTunes, Spotify, GrooveShark).

Transactions are still the bread and butter of many of the big players – eBay, Amazon, iTunes although there are new flavours e.g. Groupon. As well as network effects, it seems to me innovation in transaction models over the last couple of years has related to assurance models. Central to eBay is its rating system and trust network which provides assurance on the provenance of merchants; to some extent PayPal provides assurance for both merchants and buyers on transactions. iTunes provides a technological assurance through FairPlay by limiting use of tracks on defined number of devices. Groupon provides a broker-based assurance by making sure merchants honour deals provided the minimum threshold is achieved. Interesting, microtransactions (where transactions are measured in cents not dollars) still have not caught on; although one might argue iTunes and indeed AdWords and other advertising transactions epitomise this model.

Salesforce.com remains the poster boy of enterprise subscription models, and in particular Software as a Service. Its achievement in reaching over $1bn in revenues is to be lauded. There is no doubt their business model is a benchmark for now and the future but for whom. Salesforce’ customer base is very specific – salespeople and their support staff turn over regularly, often work at home or on the road, need up to date data at all times etc etc. Employees in HR or Accouniting do not have the same profile. Nonetheless, many companies are trying to adapt their traditional packaged software model to SaaS. Earlier in the summer, IDC forecast that less than 15 percent of net-new software firms coming to market would ship a packaged CD product and by 2014, about 34 percent of all new business software purchases would be delivered via SaaS, representing 14.5% of worldwide software spending. But the licensed/packaged software market hasn’t gone away – its still worth $300bn+ and many large and small companies alike are still uncomfortable with cloud based services. Why? Well, the larger software companies are still making a lot of money from packaged products and the transition to cloud based subscriptions has to be managed carefully. Subscription models get rid of the need for built-in obsolescence but also change the focus from repeat orders and upgrades to managing churn (or reducing non-renewal rates). They also reduce upfront licensing fees, customisation and service level fees as the customers move from a perpetual to a time-based subscription model. A wholesale change from packaged perpetual software licenses to annual subscriptions would reduce short-term revenues per customer. Lower revenues impacts earnings; earnings impact share price. SaaS means a lot of change from being product-focussed to customer-focussed, short-term revenues to long-term revenues, average revenue per customer to average revenue per user etc etc. But SaaS isn’t the only subscription derivative – e-learning companies have used rental models before Internet Delivery (see SkillSoft nee Smartforce nee CBT Group) and Netflix is doing an admirable job with DVDs. People tend to forget that their mobile service, their digital TV service and many other services using digital networks are “Internet” business models.

For me, subsidy-based models are the most interesting. Advertising dominates this class of business model. This remains primarily a B2C model – there is little evidence of enterprise acceptance of advertising-backed software and there remains policy issues in relation to advertising/sponsorship based models for education and other public sector sales. However, for those with the time, financial and technical resources, it is possible to fund your business with advertising. I, personally, also think this is a perfectly acceptable way to fund access to software particularly where no other funding is available e.g. in developing countries. However, selling advertising services (such as Facebook Ads and Google Adwords) is different than funding your business through advertising. But advertising isn’t the only form of subsidy – in the public sector, government subsidises commercial software – and in the NGO sector, foundations, governments and other agencies subsidise various initiatives including open education resources etc. It should be noted a few years ago, we assumed that there would be consolidation in digital advertising platforms and thus advertising-supported business models and choice would be less complex. The rapid adoption of social networking sites and services has fragmented – Facebook ads, LinkedIn Direct Ads and others compete with Microsoft Bing Advertising, Yahoo Advertising, and Google Adwords for advertising dollars while Twitter and others generate traffic for free. Selecting your advertising platform is getting more complicated but managing campaigns is more complex still. The number of Internet businesses that can generate enough traffic to sustain a business of any scale remains limited. This does not mean it is not happening, sites like Grooveshark, seem to be making advertising-funded services work for the music sector.

So how do you pick one? It largely depends on your market and how they perceive key elements of any given business model and again these lie in conventional business academic literature – elasticity, price, awareness, customer type etc. For example, enterprise customers know and understand transaction and licensing-based business models – they are familiar, they know the conditions, the quality and service expectations, and know the procurement dance (discounts for user volume, end of month and end of quarter pressure etc) and they control their data and uptime. They are comfortable with doing business this way. Businesses providing software funded by advertising introduce more questions than answers for enterprise buyers – will the advertising be appropriate? will it distract employees? what are the conditions and level of support (if it is “free”)? Individual users are happy to deal with this ambiguity, enterprise customers are not. Subscription-based models and in particular, the SaaS model play the middle ground. It can be argued that enterprise customers (and individuals) get enterprise software at lower cost, better service, less technical headaches with terms, conditions and procurement process that they know. They get a lot; they need to just give some trust….not the easiest thing to do even at the best of times.

Can you blend them? Yes, and this can be a source of competitive advantage. Microsoft have blended different models in their games business. You effectively license an XBOX and can then buy or subscribe to software through XBOX-Live Marketplace etc. There are free games too. Similarly I note Spotify allows you access some services with ads, a no-ads subscription service and a service where you can purchase MP3s for download and use outside of Spotify. Indeed, the Spotify model, may in time, challenge iTunes and be adopted by other media creators and aggregators; it provides a straightforward framework that addresses all consumer preferences. But this depends on their capacity to negotiate with the media rights owners worldwide (and not territory by territory) and defend against Apple at the same time.

So where does strategy come in to it? Well you can replicate any business model but this does not business success make. You still have to find a way of satisfying unfulfilled (or unknown) needs of a given market segment better than the incumbents, profitably and ideally uniquely. And that is the trick – profitably and uniquely. Whether it is one, two or each of operational effectiveness, customer targeting or innovation, successful companies have to do something better than the competition. With Internet business models, the same rules of marketing, economics, finance and strategy largely apply – segmentation, targeting, differentiation etc, etc, etc, but the successful companies move fast and tweak continuously and that is critical. They tweak digital rights management, delivery efficiency, payment options, payment process etc. The more things are different, the more they stay the same….just accelerated and more-and-more slightly left of centre.

Oh yeah, what about “free” business models? They don’t truly exist – someone has to pay.